What’s Wrong With 401(k)’s?


The Enron scandal may be the biggest corporate scam in American history, but it’s only the tip of the iceberg of a huge corner of the U.S. economy—the pension business. Today pension plans hold nearly $8 trillion of U.S. capital. Half of that amount is taken up by traditional plans in which companies pay workers a set amount from the time of retirement until they die. These accounts are more or less insured by the U.S. government, should a company fail. Another $2 trillion is accounted for by people working in the public sector, and the remaining $2 trillion by the faddish 401(k)’s, which are uninsured and float up or down with the stock market.

It is these private-investor accounts that Employee Benefit News editor Craig Gunsauley defends in his letter to the Voice (see page 6), when he writes: “Job hoppers get zero benefit from a pension plan but can build up a lot of savings in a 401(k).”

These plans have indeed become key to providing income in retirement. The nonprofit Employee Benefit Research Institute estimates 340,000 401(k) plans have been established, with 34 million participants. These plans are taking the place of traditional pensions—even in left-leaning places like the Voice—with the result that workers are losing security in their much touted golden years. “Less than one-third of the public will retire with any kind of pension of consequence,” says Paul Edwards, who heads the Coalition for Retirement Security.

In this dismal climate, 401(k) plans are popular because they offer the illusion of controlling one’s own assets. This is smoke and mirrors, because the company almost always sets up the fund to serve its own interests. It sets the parameters of what can be bought and—as the Enron case demonstrates—what can be sold and when. And the reporting system can be so Byzantine you need an accounting degree just to figure out whether you are gaining or losing money.

The plans are actually most often run by mutual fund groups or insurance companies. There is little accountability, again as Enron showed. Hidden away in the small print are numerous fees: fees to manage the pension, fees to manage the mutual fund which manages the pension, fees to pay one part of a mutual fund group to provide investment advice to another part of the same group. There are sales fees, redemption fees, and brokerage fees for buying and selling stocks. Brokerage fees can be substantial, since mutual fund managers have been concentrating on short-term investments. Mutual funds sometimes set up alliances with other fund families, which allow them to offer a wider spectrum of funds to invest in. Sometimes funds in these alliances charge each other brokerage fees. Dean Baker of the Center for Economic and Policy Research reports these costs amount to 1.5 percent of the total value of the fund. That might not seem like much, but over several years it can add up.

None of this is to say you can’t make money in a bull market if you hit the right mix. But the system has nothing to do with ensuring you a viable pension. And no one really suggests it does. Instead, 401(k)’s benefit upper-level employees who can use the tax advantages. Those tax advantages, amounting to over $330 billion last year, are a subsidy to the well-off and a further drain on programs for our most vulnerable citizens.

One of the reasons 401(k)’s are popular is that they’re virtually unregulated. They are nominally controlled by the weakling Department of Labor. It doesn’t have the staff to manage the huge pension business, and anyway regulating securities is supposed to be the job of the Securities and Exchange Commission. The SEC in turn has its hands full trying to keep up with the overall markets and thus can scarcely be expected to do much with 401(k)’s.

These investment programs do not a pension system make. They’re simply a way for corporations to use workers’ money to undertake various corporate goals such as maintaining or artificially running up the price of the stock, warding off hostile takeovers, etc. Most notably of all, the system permits companies to get out of providing pensions. It is a con game. And when the company goes bankrupt, the corporate lawyers are first in line before the judge asking to be relieved of the onerous burden of honoring health and retirement plans in the interests of restoring the corporation to good standing.

Enron has made all this an embarrassment. Something at least cosmetic must be done. The Bush administration wants to mount a reform based on disclosure. Labor Secretary Elaine Chao argues regulation would curb workers’ freedom to make choices. And it goes without saying that regulation just intervenes in the workings of the precious market. It might go through the motions of requiring so-called “independent” investment advice, which is hard to envision since all the players are intertwined with the shared goal of making money off one another, and the mutual fund families in the 401(k) business are merging.

Going a little further, Democrats in the Senate, like Kennedy, Jon Corzine, and Barbara Boxer, want to legislate diversification and maybe some arm’s-length dealing standards. This certainly isn’t bad, and perhaps would open the system to a few more people, but it doesn’t begin to address the problems of the pension system.

It’s possible to go a bit further without upsetting the Wall Street apple cart. A proposal originating from the Century Foundation several years ago sought to create an independent fund, managed by a new separate government agency and totally unconnected to the Social Security system.

In the current atmosphere in Washington, it’s hard to imagine this scheme going anywhere, but it could be implemented on the state level. In fact, the Economic Opportunity Institute in Seattle has put together just such a fund. It has been introduced into the state legislature and so far enjoys wide bipartisan support. So far it is not opposed by the mutual fund industry because it is aimed at small businesses and lower-income people, which the big players don’t want anyway. Under the Washington proposal, you could ask your employer to withhold a certain amount of your paycheck, which would go into the state retirement fund where it would be commingled with other funds in a sizable investment pool. Since the retirement system is public government—not private business—and open to scrutiny by the state legislature, there is at least an avenue for ordinary citizens to have some say, and at the very least find out what’s going on. Investment advice is organized by the state, which may ask mutual funds and other institutions in the finance industry for help, but the investment companies won’t have quite so free a rein as now.

Washington State is expected to undertake a study of how it might work, and maybe place it in operation around 2005. This model could be taken up by different states, which in due course might forge a new system.

In the meantime,there are groups outside the government and private business which are finally beginning to attract interest—such places as the Pension Rights Center and Edwards’s Coalition for Retirement Security. A Consumer Reports-style publication that explains and rates mutual funds and other managers of 401(k)’s would be a big help. Currently the only information and explanation comes through ads and the financial press, which are enmeshed within corporate America and often compromised.

A real pension doesn’t have anything to do with the stock market or whether it’s good or bad for a corporation. Properly constituted, a pension is a device to provide a decent amount of money for older people in retirement. It is the job of civil society to provide seniors such means of living as a right, just as a civil society should provide universal health care as a right. It’s a province of public government. Economic powers in the United States oppose these goals, and history suggests they will be hard to achieve. But that doesn’t make them any less necessary.

Additional reporting: Gabrielle Jackson